Deflation now?

Posted by: Michael Mandel on July 14

A year from now, will we be talking about galloping inflation or a plunge into deflation? I think the odds favor deflation, or at least lower inflation. Housing is in free-fall, and with the European economy weakening, we are looking at the prospect of sharply slowing global growth. The economists at Deutsche Bank regard this as one real possibility:

All major asset markets except those for commodities are presently weakening. This, and the fall-out from the financial crisis, could exert stronger downward pressure on global growth than anticipated in our baseline scenario. Should commodity markets then follow the other asset markets—which would seem plausible when global growth weakens by more than presently expected—inflation could drop faster and by more than anticipated in our baseline forecast. Far-fetched as it may sound at present, fears of deflation could return and interest rates could drop again towards the lows reached earlier this decade

The real question is whether the growth slowdown spreads from the developed countries to the developing world. I can’t see how it doesn’t

(For more on deflation, see Roger Bootle writing in the Telegraph with a story headlined “Deflation rather than inflation could soon be our big worry”)

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Reader Comments

Kartik

July 14, 2008 03:18 PM

Deflation is quite possible, and it may be a good thing.

Oil is presently $145, and the run-up contributed to high inflation. If oil merely drops back down to $100 (which it was 4 months ago), that is substantial deflation.

Of course, the economy will recover in the process as well, as consumers breathe relief about gasoline prices being tolerable again.

Rycoka

July 14, 2008 11:01 PM

I agree that deflation scenario looks likely (it could be argued that the current situation is already deflationary, if you focus on equities for example). I am not so sure about it being a good thing.

The problem with deflation is that it tends to make certain amounts of activity (activity that provides people with livelihoods) uneconomic. This leads then to unemployment, which leads to less buying power which leads to less economic activity etc.

This kind of spiral seems more likely and potentially more virulent than an inflationary spiral, given that workers in a globalised market place have little ability to force wages higher.

Joe Cushing

July 15, 2008 04:20 PM

I see the credit crunch as deflation. We are certainly experiencing a reduction in the multiplication of the money supply. This could create Deflation in the short term. This kind of deflation is not sustainable and is reversible in the next upturn. Since downturns usually last about 400 or so days; what is scary about this is that the fed will over pump cash into the system right about the time we are having a reversal of the credit crunch. This would be very inflationary indeed.

I'm still in favor of the do nothing approach. Don't inject more money, don't lower interest rates, don't raise interest rates--leave everything the way it is now. In a year or so, this will all be over. Then raise interest rates.

Dave

July 15, 2008 04:29 PM

We had better hope we don't see deflation. If the economic slowdown is so great as to overcome the inflationary pressures of mindlessly printing money to fund a useless war and support an exploding trade deficit, well, get ready for the next great depression.

Viking

July 16, 2008 01:04 AM

Since the current spike in inflation is driven mainly by commodity and raw materials prices including oil,it is quite possible that we could approach deflation a year from now.We are not facing a wage spiral or other embedded inflation expectations,so as soon as world growth slows down sufficiently,as it will,to lessen demand for these items,their prices will come down,possibly dramatically,so we can go from inflation worries to deflation worries quite fast.However we have to let this process happen at it's own pace,as it is important to let supply of these raw materials catch up to demand.The slowdown in world growth will temporarely close the gap,thus allowing prices to fall,but ultimately the process require time to allow new production to occur and to find ways to use these items more efficiently.This is also the reason I am against further cuts in interest rates or other attempts to prop up the economy at this time,as it will only postpone the date when this adjustment will occur,but causing immense damage to our currency in the meantime.When prices and inflation drop,then interst rates can be lowered further to deal with the threat of deflation.

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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